Writing a New "Chapter 12"

06/14/2010 11:24 am EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, says companies that emerge from bankruptcy can be good investments, and he likes a big auto supply company.

From time to time, we have written about the stocks of companies emerging out of Chapter 11 and why they can be attractive.

Even though the company that emerges from Chapter 11 is likely to be much stronger than the company that first sought bankruptcy protection, many people let their memories of the troubled pre-bankruptcy business color their analysis of the post-bankruptcy stock.

Another reason why post-bankruptcy stocks may lag for a significant period is that even though an individual company may have fixed many of its particular problems through Chapter 11, it may be part of a broader industry that is still suffering. As a result, the post-bankruptcy stock will not perform well until overall industry conditions begin to improve.

Lear (NYSE: LEA) is a major global supplier to automobile manufacturers, producing seat systems and electrical power management systems. The company grew rapidly, making 18 acquisitions since becoming a public company in 1994.

However, these acquisitions left Lear with a high level of debt, which caused the company to struggle when worldwide auto production began to decline sharply in 2007. Lear filed for Chapter 11 [protection] in July 2009, but it was able to emerge from bankruptcy only four months later.

Lear actually began to reshape itself well before it filed for Chapter 11. Since 2005, it has closed 35 manufacturing and ten administrative facilities, and cut its headcount by 35,000. Much of this restructuring focused on moving away from high-cost locations with the result that today half of Lear’s facilities and 75% of its workforce [is] based in low-cost countries.

The Chapter 11 filing allowed the company to complete its restructuring by reshaping its balance sheet. When Lear emerged from Chapter 11, it had less than $930 million in long-term debt, compared to more than $2.3 billion at the end of 2007.

During the first quarter of 2010, the company was able to further refinance so that by early April it had only about $745 million in debt—at a low interest rate and with no maturities until 2018—and $1.3 billion in cash.

While automobile sales still have a long way to go to recover to historical levels, there are signs that a turnaround is under way globally. In the first quarter of 2010, worldwide automobile production was up 47% over the prior year. Lear has a large backlog of business, and recently boosted its guidance for 2010 results.

As Lear returns to profitability, shareholders could gain in several different ways. As investors become more comfortable with the rebound in the automotive sector, they will value Lear’s stock more highly. [And] with strong cash flow, Lear could reinstitute a dividend.

Also, as the automotive supply business continues to consolidate, Lear could be either an acquirer or an acquisition target.

We recommend buying Lear up to $90. (It closed below $66.50 Friday—Editor.)

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